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MANAGERIAL ECONOMICS
Lecturer:
Mr. Yoopi Abimanyu, Ph.D.
Composed by:
ANDY
000009361
MAGISTER MANAGEMENT
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TABLE OF CONTENTS
Cover Page....1
Table of Contents.....2
Sweezy Oligopoly..3
Cournot Oligopoly4
Stackelberg Oligopoly..5
Bertrand Oligopoly..6
Contestable Markets....7
Bibliography.....8
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BASIC OLIGOPOLY MODELS
Oligopoly refers to a market structure in which there are only a few firms (usually
ranging from 2 to 10), each of which is large relative to the total industry. Such
oligopolistic firm (oligopolist) is most difficult to manage since the manager shall
consider the impact of his/ her decision on other firms. Demand for an oligipolists
product highly depends on how the rivals respond to its pricing decision: whether they
will match the price changes (in which demand will become more inelastic) or not.
There are four models of oligopoly, each of which has different implications for the
managers optimal decision as a result of rivals different responses to a firms action.
Sweezy Oligopoly
Sweezy model is an industry in which there are few firms serving many customers;
the firms produce differentiated products; each firm believes rivals will respond to a
price reduction, but will not follow a price increase; and barriers to entry do exist.
In Sweezy oligopoly, there is a range (CE) over which changes in marginal cost will
not affect the profit-maximizing output and thus, there is no incentive for the firms to
change their pricing behavior due to the assumptions that rivals will match a price cut,
but not a price increase. This is the reason why Sweezy gasoline retailers in some
areas may not decrease their price despite the fall in their marginal cost as a result of
oil price decline.
Sweezy model shows that strategic interaction amongst firms and managers belief on
rivals reactions can have profound impact on pricing decision. However, this model
is criticized for no explanation on how the industry settles on the initial price (P0) that
generates kink in every firms demand curve.
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Cournot Oligopoly
Cournot model is an industry in which there are few firms serving many consumers;
the firms produce differentiated or homogeneous products; each firm believes rivals
will hold their output constant if its output is changed; and barriers to entry do exist.
And
The greater the output of a firm; the lower the demand, marginal revenue, and profit-
maximizing output of the rival.
In Cournot oligopoly, industry output is below socially efficient level since P > MC
and thus, there is deadweight loss. The amount by which P > MC depends on number
of firms in the industry and the degree of product differentiation. In homogeneous-
product Cournot oligopoly with large number of firms, equilibrium price is close to
MC and industry output approximates perfect competitions with no deadweight loss.
Basic tool to summarize Cournot oligopolists profit is isoprofit curve, which defines
the output combination of all firms that yield a given firm the same profit level. Every
point on isoprofit curve yields the same profit level. The closer the isoprofit curve to a
firms monopoly output, the higher the profit. Isoprofit curve reaches its peak when it
intersects the firms reaction function. However, isoprofit curves do not intersect each
other.
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In Cournot oligopoly, marginal cost reduction shifts
a firms reaction function upward (r**), leading to a
new equilibrium (F) at the firms higher output
(Q2**) and market share, but at the rivals expense
of lower output (Q1**).
Colluding firms will enjoy higher profit than Cournot oligopolists (collude > Cournot).
The output levels that yield such colluding firms higher profits are shown by shaded
lens-shaped area in Figure 4, while output combinations that maximize total industry
profit is denoted by line AB.
Stackelberg Oligopoly
Stackelberg model is an industry in which there are few firms serving many
customers; the firms produce differentiated or homogeneous products; a single firm
(the leader) chooses its output before rivals select theirs; all other firms (the
followers) take the leaders output as given and select their profit-maximizing outputs
given such leaders (behave like Cournot oligopolists); and barriers to entry do exist.
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Leader has first-mover advantage by choosing a point of profit-maximizing output
(Q1) on the followers Cournot reaction curve. Hence, the leaders profits (1) are
higher than that in Cournot equilibrium (C), but the followers profits are lower.
and
Bertrand Oligopoly
Bertrand model is an industry in which there are few firms serving many customers;
the firms produce identical products at a constant marginal cost; firms compete in
price and react optimally to rivals prices; consumers have perfect information and
there are no transaction costs; and barriers to entry do exist.
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differentiated-product market are upward sloping and thus, the equilibrium occurs at a
point where P > MC.
Contestable Markets
Contestable market is an industry in which all firms have access to the same
technology; consumers respond quickly to price changes; incumbent firms cannot
respond quickly to an entry by lowering their prices; and there are no sunk costs. In
such a market, potential incumbent firms have no market power over customers and
strategic interaction between incumbents and potential entrants is similar to Bertrand
oligopoly. Hence, the equilibrium price corresponds to marginal cost (P = MC) and
firms earn zero economic profits.
The absence of sunk costs is important for contestable market since if sunk costs exist
and potential entrant believes that incumbents will lower their prices to respond to its
entry, the entrant may be left with no customers and such new entry will be
unprofitable. In this case, incumbents may not be disciplined by potential entry and
higher prices may prevail.
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BIBLIOGRAPHY
Michael R. Baye. 2010 Managerial Economic and Business Strategy, 7th ed.
McGraw-Hill.